Flow-Based Asset Pricing
In any market with uninformative flows, the maximum Sharpe-ratio portfolio can be separated into two. The first portfolio uses only fundamental information to maximize the Sharpe ratio. The second portfolio provides liquidity to uninformative flows and maximizes price impact ratio, which is defined as a portfolio’s price impact over its fundamental risk. We develop the factor model of price impacts to empirically investigate the maximum-price-impact-ratio (MPIR) portfolio. For U.S. equity mutual fund flows, we find that the MPIR portfolio constructed using flows into Fama and French (1993) factors is a good choice.
Notre Dame, Johns Hopkins Carey